With its stock down 15% over the past three months, it is easy to disregard ConocoPhillips (NYSE:COP). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to ConocoPhillips' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for ConocoPhillips is:

21% = US$11b ÷ US$49b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

ConocoPhillips' Earnings Growth And 21% ROE

At first glance, ConocoPhillips seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. Consequently, this likely laid the ground for the impressive net income growth of 27% seen over the past five years by ConocoPhillips. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared ConocoPhillips' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 38% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is COP worth today? The intrinsic value infographic in our free research report helps visualize whether COP is currently mispriced by the market.

Is ConocoPhillips Making Efficient Use Of Its Profits?

ConocoPhillips' three-year median payout ratio is a pretty moderate 46%, meaning the company retains 54% of its income. So it seems that ConocoPhillips is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, ConocoPhillips has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 33% over the next three years. However, ConocoPhillips' future ROE is expected to decline to 17% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.

Summary

On the whole, we feel that ConocoPhillips' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com